Epstein v. McA, Inc.

This case is before us on remand from the United States Supreme Court. In Matsushita Electric Industrial Co. v. Epstein, 516 U.S. 367, 116 S.Ct. 873, 134 L.Ed.2d 6 (1996) ("Matsushita "), the Court reversed our judgment in Epstein v. MCA, Inc., 50 F.3d 644 (9th Cir.1995) ("Epstein I "), and remanded "for proceedings consistent with this opinion." Matsushita, 516 U.S. at ----, 116 S.Ct. at 884.

The case is a class action brought by former MCA shareholders who surrendered their stock in response to a tender offer by Matsushita. In Epstein I, the named plaintiffs ("the Epstein plaintiffs") contended, inter alia, that Matsushita's tender offer violated the so-called "all-holder, best-price" rule of SEC Rule 14d-101 by paying a premium for the stock of MCA's chairman and chief executive officer, Lew Wasserman, and MCA's chief operating officer, Sidney Sheinberg.2 The district court awarded summary judgment to the defendants, and the Epstein plaintiffs appealed.

In Epstein I we reversed the summary judgment for Matsushita, holding that its agreement to purchase Mr. Wasserman's stock for consideration different from what it offered other shareholders violated Rule 14d-10, see Epstein I, 50 F.3d at 653-57, and that there was a material issue of fact as to whether a $21-million dollar payment to Mr. Sheinberg was legitimately made as incentive compensation for past services or was a premium for his stock paid in violation of Rule 14d-10. See id. at 657-59. We rejected Matushita's argument that there was no private right of action under § 14(d)(7) of the Williams Act, following the decisions of the Second and Third Circuits on that point.3 See id. at 649-52. We also rejected Matsushita's argument that its purchase of Mr. Wasserman's stock could not have violated Rule 14d-10 because his stock was not exchanged until one hour after Matsushita accepted the tendered MCA shares for payment. See id. at 654-57. We also held that the district court had abused its discretion in refusing to certify the class because "[t]he claims of every tendering shareholder turn on identical facts and law--regardless of the identity or circumstances of the particular shareholder." Id. at 668. Finally, we affirmed the district court's dismissal of the "aiding and abetting" claims against MCA and Messrs. Wasserman and Sheinberg personally in light of the Epstein plaintiffs' concession on the issue. See id. at 665 n. 29.

None of these rulings on the merits of the Rule 14d-10 claims were disturbed by the Supreme Court in Matsushita. The Court reversed our judgment and remanded for further proceedings solely on the basis of the first question presented in Matsushita's petition for the writ of certiorari: "Whether a federal court can withhold full faith and credit from a state court final judgment approving a class action settlement simply because the settlement released exclusively federal claims."4 Matsushita Electric Indus. Co. v. Epstein, 515 U.S. 1141, 115 S.Ct. 2576, 132 L.Ed.2d 826 (1995) (granting certiorari limited to Question 1 presented by the petition for writ of certiorari); see also Matsushita, 516 U.S. at ----, 116 S.Ct. at 884 (remand order).

On remand, the Epstein plaintiffs press anew an argument that we found unnecessary to address in Epstein I: that we should withhold full faith and credit from the Delaware judgment because it was entered into in violation of the due process right of the absent class members to adequate representation at all times. We now turn to that question.

* Matsushita contends that we are barred from addressing the merits of the Epstein plaintiffs' claims of inadequate representation. Matsushita makes three arguments in support of this contention:

(1) The Supreme Court's decision in Matsushita did not leave the issue open on remand;

(2) The issue of the adequacy of representation was fully and fairly litigated in the Delaware Court of Chancery;

(3) The Epstein plaintiffs are estopped from raising the adequacy of their representation collaterally because they did not raise it by intervening in the Delaware proceeding.

* In arguing that the "[t]he opinion of the Supreme Court leaves no issue open on remand," Appellees' Br. at 1, Matsushita either mischaracterizes or disregards the unambiguous statements in the record to the contrary:

1. Matsushita fails to cite the Court's order granting certiorari, which limited the question it would review to Question 1 in Matsushita's petition. See Matsushita Electric Industrial Co. v. Epstein, 515 U.S. 1141, 115 S.Ct. 2576, 132 L.Ed.2d 826 (1995); see also Matsushita, Pet. for Cert., at i ("1. Whether a federal court can withhold full faith and credit from a state court final judgment approving a class action settlement simply because the settlement includes a release of exclusively federal claims.").

2. Matsushita fails to include the first sentence of the Court's opinion which limited the question presented precisely the way Matsushita stated it in its petition for certiorari:

This case presents the question whether a federal court may withhold full faith and credit from a state-court judgment approving a class-action settlement simply because the settlement releases claims within the exclusive jurisdiction of the federal courts.

Matsushita, 516 U.S. at ---- - ----, 116 S.Ct. at 875-76.

3. Matsushita, although quoting various excerpts from the Court's opinion, fails to quote the following explicit statement by the Court that it did not address the due process claim:

We need not address the due process claim [of inadequate representation] ... because it is outside the scope of the question presented in this Court. See Yee v. Escondido, 503 U.S. 519, 533, 112 S.Ct. 1522, 1531, 118 L.Ed.2d 153 (1992). While it is true that a respondent may defend a judgment on alternative grounds, we generally do not address arguments that were not the basis for the decision below. See Peralta v. Heights Medical Center, Inc., 485 U.S. 80, 86, 108 S.Ct. 896, 899, 99 L.Ed.2d 75 (1988).

Id. at ----, n. 5, 116 S.Ct. at 880, n. 5.

4. Matsushita also fails to cite the explicit statement in Justice Ginsburg's separate opinion that the due process question of adequate representation remained open on remand, a statement that went unchallenged by any member of the Court:

Mindful that this is a court of final review and not first view, I do not address the merits of the Epstein plaintiffs' contentions [regarding the adequacy of representation], or Matsushita's counterargument that the issue of adequate representation was resolved by full and fair litigation in the Delaware Court of Chancery. These arguments remain open for airing on remand.

Id. at ----, 116 S.Ct. at 890 (Ginsburg, J., concurring in part and dissenting in part) (emphasis added).

5. Finally, in arguing that the due process question is not open on remand, Matsushita ignores its own assertions to the Court that the question was not before it for decision. In their brief, the Epstein plaintiffs invited the Court to address the adequacy of representation issue, notwithstanding that it was outside the scope of the sole question on which the Court had granted certiorari. See Matsushita Resp. Br. at 34-45. In its Reply Brief, Matsushita responded:

A. The Ninth Circuit Opinion is Not Predicated Upon Any Due Process Issue.

Respondents invite this Court to find constitutional infirmity in the Delaware proceedings based on alleged inadequate representation and judicial supervision. Resp. Br. at 34-45. As respondents concede, the Ninth Circuit's holding is not predicated on these fact-specific issues. Resp. Br. at 8. Accordingly, this Court should decline to address them.

Matsushita Reply Br. at 13.

Given this state of the record, we must agree with the Epstein plaintiffs that Matsushita's argument that the due process question is not open on remand is "inexplicable." Reply Br. at 4. Matsushita attaches no weight to the Supreme Court's clear disclaimer that "We need not address the due process claim," Matsushita, 516 U.S. at ----, n. 5, 116 S.Ct. at 880, n. 5., and all the other references in the record that reaffirm this disclaimer.

Instead, Matsushita attempts to get around the Court's unambiguous disclaimer. First, it seizes upon language in the Court's opinion concerning Delaware preclusion law and lifts it out of context. "State-court approval of the settlement would have the collateral effect of preventing class members from prosecuting their claims in federal court." Matsushita, 516 U.S. at ----, 116 S.Ct. at 879; accord Appellees' Br. at 12. While an accurate summary of the Supreme Court's reading of Delaware preclusion law, this passage lends no support to the argument that the Supreme Court addressed, let alone disposed of, the Epstein plaintiffs' inadequate representation claim.

Matsushita's position that the Court in Matsushita implicitly held that the Delaware proceeding satisfied due process reads volumes between the lines. When taken in the face of the Court's explicit announcement that it did not render such a holding, we agree with the Epstein plaintiffs that it becomes nothing less than "incomprehensible." Appellants' Br. at 5.

Matsushita's second ground for arguing that adequacy of representation is not open on remand rests on the very footnote--from which it selectively excerpts--in which the Court expressly stated that it was not addressing due process. Matsushita misleading quotes only the first part of the footnote, which reads as follows:

A part [sic] from any discussion of Delaware law, respondents contend that the settlement proceeding did not satisfy due process because the class was inadequately represented.... Respondents make this claim in spite of the Chancery Court's express ruling, following argument on the issue, that the class representatives fairly and adequately protected the interests of the class....

Id. at ----, n. 5, 116 S.Ct. at 880, n. 5 (citations omitted). Matsushita omits the very next sentence of the footnote, however, in which the Court made clear that it was not disposing of the due process claim.

We need not address the due process claim, however, because it is outside the scope of the question presented in this Court.

Id.

Matsushita would have us believe that the Court was "winking" at us--saying that it was not doing exactly what it was doing. The only reasonable interpretation of these sentences, however, is that the Court was simply stating the claim of the Epstein plaintiffs that their representation in the Delaware proceeding was constitutionally inadequate.

In sum, we reject Matsushita's argument that the Supreme Court did not leave the due process issue open on remand. The Court laid out an unambiguous contrary intention in its statement of the question presented and in footnote five, and no voice was raised against Justice Ginsburg's explicit statement that the issue of adequacy of representation "remain[ed] open for airing on remand." Id. at ----, 116 S.Ct. at 890 (Ginsburg, J., concurring in part and dissenting in part).

Next we address Matsushita's argument that the Delaware settlement judgment precludes the Epstein plaintiffs from "relitigating" the issue of adequacy of representation under Delaware issue preclusion law. It claims that adequacy of representation was actually litigated by objectors at the Delaware fairness hearing, and that other Delaware courts would therefore give preclusive effect to the Chancery Court's determination that representation of the absent class members was adequate. Appellees' Br. at 16-18, 21-24, 22 n. 6. Therefore, Matsushita argues, under 28 U.S.C. § 1738, we too must attach issue preclusion. See id. at 23.

The Epstein plaintiffs argue in response that the Delaware judgment raises no issue preclusion bar to the question of constitutional adequacy of representation. First, they contend, the objectors did not actually litigate the issue at the Delaware fairness hearing, as is required under Delaware issue preclusion law. See Appellants' Br. at 21-23; Reply Br. at 10. More broadly, the Epstein plaintiffs contend that individual, uncertified objectors in a class action cannot constitutionally bind absent class members on the issue of adequacy of representation. See id. at 17-18. We consider each contention in turn.

* Under Delaware law, issue preclusion attaches only when a question of fact essential to the judgment has been actually litigated and determined by a valid and final judgment. See Messick v. Star Enterprise, 655 A.2d 1209, 1211 (Del.1995) ("The test for applying collateral estoppel requires that (1) a question of fact essential to the judgment, (2) be litigated and (3) determined (4) by a valid and final judgment.") (internal quotations omitted) (emphasis added); Orange Bowl Corp. v. Jones, 1986 WL 13095, at * 2 (Del.Super.1986); Evans v. Frank E. Basil, Inc., 1986 WL 3973, at * 2 (Del.Super.1986). The Delaware record shows clearly that the issue of adequacy of representation was not litigated during the settlement proceedings.

First, the notice to class members said nothing about adequacy of representation. Instead, the notice stated that the purpose of the settlement hearing was to determine "(a) the fairness, reasonableness, and adequacy of the terms of the ... Settlement, and (b) whether an order and final judgment should be entered approving the proposed settlement." Supplemental Record ("SR") 354 (emphasis added). Whether the class was adequately represented by the named plaintiffs or by class counsel was not an issue noticed for hearing. Thus, absent class members were not on notice that they could have objected to the adequacy of representation at the settlement hearing.

Not surprisingly, the objectors who did appear at the settlement hearing did not litigate the adequacy of their representation. Objector Marion Minton focused solely on the issue of inadequate notice. See SR 375. Objector Pamela Minton de Ruiz, in her memorandum to the Chancery Court, framed her objection in terms of collusion, arguing that "[t]he second proposed settlement is collusive and should not be approved." SR 402. Likewise, the Minton objectors argued at the settlement hearing that "this two-cent settlement is collusive." SR 574. Neither of the Minton objectors focused on the much broader issue of whether representation was constitutionally adequate. See SR 402-09.5 Finally, objector William A. Krupman did submit an affidavit to the Chancery Court stating that he opposed the settlement because "the purported class representatives ... had proposed a settlement that benefitted no one but their own attorneys. They did not provide adequate representation." SR 422-23. However, this single blanket statement conflating the non-constitutional question of the fairness of the settlement with the constitutional question of the adequacy of representation hardly qualifies as "actual litigation" of the constitutional issue. Indeed, in his argument at the settlement hearing, objector Krupman did not address the constitutional adequacy of the representation, but argued only that the terms of the settlement were unfair. See SR 589-91.

Since the issue of adequacy of representation was never actually litigated in Chancery Court, no Delaware court would attach preclusion to the issue of adequate representation of the absent class members. See Star Enterprise, 655 A.2d at 1211. Under § 1738, neither may we. See, e.g., Migra v. Warren City School Dist. Bd. of Educ., 465 U.S. 75, 88, 104 S.Ct. 892, 899-900, 79 L.Ed.2d 56 (1984) (White, J., concurring) (collecting cases).6

Even if adequacy of representation had actually been litigated by objectors at the fairness hearing, and even if Delaware law would allow an individual objector to bind an absentee on the issue of adequacy of representation--however improbable that might seem--we still could not give full faith and credit to such a judgment because it would violate due process of law. As the Epstein plaintiffs aptly put it, "[o]bjectors are objectors, not class representatives. " Reply Br. at 17-18. Binding absentees to any part of a class action judgment "is an act of judicial power," Epstein I, 50 F.3d at 667, and that power can only be exercised over absentees when their interests have, in fact, been adequately represented by parties lawfully authorized to represent them. See, e.g., Richards v. Jefferson Cty., Ala., 517 U.S. 793, ----, 116 S.Ct. 1761, 1766, 135 L.Ed.2d 76 (1996) ("[O]ne is not bound by a judgment in personam in a litigation in which he is not designated as a party ... [except, in a class action, where he] has his interests adequately represented."). It would defy this fundamental principle of our jurisprudence to allow the due process right of absent class members to adequate representation to be litigated by random, volunteer objectors.7

Not surprisingly, Matsushita offers no persuasive authority in its attempt to argue against this basic principle. Some of the cases that it cites involve individual litigants, not class members. In Durfee v. Duke, 375 U.S. 106, 84 S.Ct. 242, 11 L.Ed.2d 186 (1963), for example--upon which Matsushita relies heavily--the Supreme Court held that an individual who has unsuccessfully challenged subject matter jurisdiction in an initial action can be precluded from raising the issue in a collateral attack on the judgment. Durfee was not a class action and says nothing about the rights of absent class members. Some of Matsushita's other cases pre-date Phillips Petroleum v. Shutts, 472 U.S. 797, 105 S.Ct. 2965, 86 L.Ed.2d 628 (1985), the controlling Supreme Court precedent on the rights of absent class members. See infra, Section I.C. See, e.g., Laskey v. International Union, United Auto., Aerospace & Agric. Implement Workers (UAW), 638 F.2d 954 (6th Cir.1981). The only case Matsushita cites that offers any help on its proposition that volunteer objectors can litigate the due process rights of absent class members is Grimes v. Vitalink Communications, 17 F.3d 1553 (3d Cir.1994). In Grimes, the Third Circuit held that objectors may litigate the due process rights of absent class members who have sufficient minimum contacts to support an exercise of personal jurisdiction over them by the forum. It reasons that, so long as an absentee has "minimum contacts" with the forum, he can be bound by the judgment without receiving Shutts ' safeguards. See Grimes, 17 F.3d at 1558-59, 1560 & n. 8. There is nothing in Shutts, however--or in any other case--to suggest that Shutts offers protection only to those absentees who are beyond the in personam reach of the forum. Because Grimes conflates the requirements of in personam jurisdiction with the due process safeguards that Shutts guarantees to absent class members, we respectfully decline to follow it.

Finally, Matsushita raises the alarmist cry that it will sound the death knell to finality in class actions if individual objectors cannot bind absentees on the issue of adequate representation. See Appellees' Br. at 2. We of course reject this hyperbole. So does Delaware. In Prezant v. De Angelis, 636 A.2d 915 (Del.1994), the Delaware Supreme Court points out that prudent class action defendants can protect themselves from collateral attack. Although they cannot foreclose a subsequent collateral action absolutely, they can minimize the risk by asking for a judicial finding, supported by reasons and evidence in the record, that the plaintiffs' "due process right to adequate representation has been satisfied." Prezant, 636 A.2d at 925-26. Such a finding will "help insure" that judgments will be subject to collateral attack only under extraordinary circumstances like those that exist in this case. See id. Thus, we disagree with Matsushita that finality of settlements will come to an end if volunteer objectors are not vested with the authority to bind absentees on the issue of the adequacy of class representation.

To repeat, "[o]bjectors are objectors, not class representatives." Reply Br. at 17-18 (emphasis removed). The individual objectors who voluntarily appeared at the fairness hearing were not authorized by the absentees to represent their interests, nor were they certified by the state to do so. Their appearance at the hearing did not bind anyone but themselves to an adjudication of adequacy of representation.

Finally, Matsushita argues that because of the procedures used in the Delaware Chancery Court, the Epstein plaintiffs cannot bring a collateral attack on adequacy of representation. This argument comes in two parts. First, Matsushita argues, the settlement hearing provided a "full and fair opportunity" for absentees to contest the adequacy of their representation. Appellees' Br. at 25. The absentees had a duty to intervene in that hearing if they wished to protect their rights, Matsushita claims, and having failed to do so, they are estopped from bringing a collateral challenge. Second, and more broadly, Matsushita argues that the procedures Delaware had in place foreclose us from ever hearing a collateral challenge to adequacy of representation. Matsushita argues that we are limited to reviewing the sufficiency of the procedures that Delaware had in place to ensure adequate representation, rather than the adequacy of the representation itself. "[T]he Chancery Court's adherence to Rule 23 procedures satisfies the Due Process Clause as a matter of law," Matsushita continues, and an absent class member's claim on "the merits" of inadequate representation "is far outside the scope of the [collateral] review permitted by ... the case law of this Court." Appellee's Br. at 30. We agree with the Epstein plaintiffs that both of these arguments are meritless.

* Matsushita argues that class members who wish to contest adequacy of representation must intervene during the course of the class action proceedings and do battle with their own representatives in an adversarial contest over the way they are discharging their fiduciary duties. This argument ignores the clear teaching of Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 105 S.Ct. 2965, 86 L.Ed.2d 628 (1985), that a class member is not required to do anything during the course of a class-action proceeding. He is free to sit it out, assured that he will be bound by the result if, but only if, the proceeding comports with the special due process requirements designed to safeguard the interests of absent class members. As the Court put it in Shutts, "Unlike a defendant in a normal civil suit, an absent class-action plaintiff is not required to do anything. He may sit back and allow the litigation to run its course, content in knowing that there are safeguards provided for his protection. " Id. at 810, 105 S.Ct. at 2974 (emphasis added). Those "safeguards", as enumerated in Shutts, are (1) "notice," (2) "an opportunity to be heard and participate in the litigation," (3) "an opportunity to remove himself from the class" by opting out, and (4) "adequate represent[ation]" "at all times. " Id. at 812, 105 S.Ct at 2974 (emphasis added). Thus, Shutts admonishes absent class members that they will be bound by the merits of a judgment--including the fairness of a court-approved settlement--if it is a product of adequate representation and their other due process safeguards. But Shutts promises in return that they need not monitor this proceeding from afar: if the litigation culminating in the judgment violated their due process rights, then absent class members will not be bound by it.

Gonzales v. Cassidy, 474 F.2d 67 (5th Cir.1973)--a precursor to Shutts--is square authority against Matsushita's intervene-or-be-estopped argument. In Gonzales, the Fifth Circuit rejected the very argument that Matsushita now urges upon us: "[The defendants] advance an estoppel-type argument to support the proposition that [the absent class member] cannot raise the inadequate representation issue [on collateral review]. Their position is that [the absent class member] is estopped to attack the judgment because he should have intervened." Id. at 76.

In rejecting this argument and holding that an absent class member may collaterally attack a judgment on the ground that he was not adequately represented, the Fifth Circuit reasoned that the question "whether counsel's conduct of the entire suit was such that due process would not be violated by giving res judicata effect to the judgment in that suit," id. at 74, "necessarily requires a hindsight approach. " Id. at 73 n. 11 (emphasis added). As the court went on to say, "The purpose of Rule 23 would be subverted by requiring a class member who learns of a pending suit involving a class of which he is a part to monitor that litigation to make certain that his interests are being protected...." Id. at 76.8

A hypothetical based on the facts of our case serves to illustrate the common sense soundness of Shutts and Gonzales and the impracticality of Matsushita's argument that the Epstein plaintiffs are now estopped from challenging the adequacy of representation because they failed to intervene at the fairness hearing. Suppose a class member did appear as an objector at the hearing and challenged the fairness of the settlement on the ground that it had not taken into account the claim that a $21-million payment to Sheinberg was in reality a premium for his stock. See infra, Section II.B.2. Suppose further that the objector produced evidence in the form of deposition testimony and documents--perhaps discovered in a parallel federal class action--casting doubt on the real purpose of the $21-million payment. Suppose still further that Delaware counsel had never heard of the $21-million payment before the objector reported it at the fairness hearing.

The question is: how should class counsel have responded to this new evidence about the Sheinberg payment during the middle of the fairness hearing, given their fiduciary duty to look after the interests of all members of the class? The obvious answer would seem to be to ask the Vice Chancellor to continue the fairness hearing until they had a chance to learn more about the Sheinberg payment and consider its potential settlement value. After all, if there was evidence to prove that the $21-million payment was a premium to get Mr. Sheinberg to support the tender offer, it would take only a simple calculation to determine that other shareholders would be entitled to a substantial recovery. See infra, Section II.B.2.

Let us suppose, however, that for whatever reason--perhaps the irresistability of a quick fee on claims they could not litigate--counsel stuck to their guns and got the proposed settlement--2 per share (less attorneys fees)--approved and cast into a judgment. Could the law possibly be that all the class members who failed to intervene at the fairness hearing are estopped from challenging the judgment collaterally on the ground that they were not provided adequate representation? Common sense as well and Shutts and Gonzales dictate that the answer must be that they are not.

This dilemma is the driving force behind Gonzales ' reasoning. The impracticality of assessing the adequacy of ongoing representation "live-time" is the very reason that the Fifth Circuit in Gonzales insisted that the challenge must be conducted with a "hindsight" approach, as on collateral review. Matsushita attempts to turn this around and limit Gonzales ' scope to cases in which it was "impossible to raise" the constitutional claim in the original proceeding. See Appellees' Br. at 35-26 ("Gonzales also turns on the impossibility of participation in the original proceeding.... Gonzales thus stands for the limited proposition that [collateral attack is limited to] due process violations that could not have been presented in the rendering court prior to the entry of judgment.").

This is not what Gonzales held. On the contrary, it held that even claims that were not "impossible" to have been raised in the initial proceedings are entirely appropriate for collateral review:

To answer the question whether the class representatives adequately represented the class so that the judgment in the class suit will bind the absent members of the class requires a two-pronged inquiry: (1) did the trial court in the first suit correctly determine, initially, that the representative would adequately represent the class? and (2) Does it appear, after the termination of the suit, that the class representative adequately protected the interest of the